You can take out a home equity loan for a second residence down payment. In most cases, the sum you receive through your home equity loan will not be large enough to fully cover the cost of a second home. However, covering the down payment and closing costs through a home equity loan can give you the flexibility to purchase a residence you would not otherwise afford.
Buying a Home Outright
If you are one of the fortunate few who has enough equity to totally cover the purchase of a second home, you have unique considerations. The loan size you can achieve on your home equity loan is completely based on how much of your current home you own. If you have paid off your first mortgage, then you will own 100% of your current home. In this case, a portion of the home's value can be used to purchase a second residence. Since this portion is rarely greater than 70-80%, you will be purchasing a home that is less expensive than your current property. That being said, if you can find enough funds through your home equity to completely pay for a new home, then you will not need to worry about a down payment size or a second mortgage.
Covering a Down Payment
Most people will not be able to fully cover the purchase price of a home with a home equity loan from their private property. As such, they will be using the first home equity loan in order to create a down payment for the new house. The main benefit here is to be able to provide a much larger down payment, reducing the size and cost of a second mortgage. The interest rate will be much lower on a high down payment mortgage; the limits will also be lower, meaning you can pay the loan off faster. Providing a 20 or 30% down payment is not likely an option you had for your first home. Taking advantage of it later will truly be putting your equity to use.
Paying the Debts
If your home equity loan does not fully cover the cost of a second home, then you will also be taking another mortgage. This mortgage payment will need to be made along with the home equity loan payment and any current mortgage you have on your primary residence. In total, you could be potentially paying three housing loans each month. This situation is what leads many people, even those with high incomes, into situations where they can no longer afford their mortgages. Foreclosures are most common for people who overextend the debt they owe on a property. Once you have built up equity in your home, you should aim to keep your debt to equity ratio in a good balance. It is hard to determine what a good balance is for a lot of people. As a rule, though, aiming for 3:1 equity to debt is a safe way to ensure you always have assets to cover any debt you cannot pay.